DraftKings paid millions to cover shortfalls last weekend; company says it's part of marketing

Daily fantasy sports operator DraftKings paid out millions of dollars this past weekend to cover shortfalls from unfilled NFL contests that offered large guaranteed prize pools, sources told ESPN.

While competitors FanDuel and Yahoo also fell short of having enough players to cover some guaranteed prize pool payouts, DraftKings saw the largest gap, industry sources and high-volume players said. The Boston-based firm had an estimated total of $2 million to $4 million in "overlay" -- the amount of the guaranteed prize pool not covered by entry fees -- making it one of the largest weekly-game shortfalls for a daily fantasy operator, the sources said.

A DraftKings spokesperson disputed the $4 million estimate, calling it "grossly exaggerated," but declined to provide the exact amount of the total overlay. The spokesperson also said the unfilled contests were planned as such, and the cost was viewed as a "marketing expense" in line with weekly overlays that occurred in prior seasons.

DraftKings' biggest NFL contest last weekend, the "Millionaire Maker," offered a $5 million guaranteed prize pool, with a $3 entry fee. More than 1.4 million entries, totaling approximately $4.3 million, competed for the contest's million-dollar grand prize. That left approximately $700,000 that DraftKings had to pay out to contest winners. Several other DraftKings contests also failed to attract enough entries to reach guaranteed prize pool amounts. An NFL contest with a $2.5 million guaranteed prize pool and $20 entry fee had approximately $200,000 in overlay. At least 16 of the site's largest contests lacked an adequate number of entries just seconds ahead of Sunday's early NFL kickoffs, indicating they also fell short of covering the guaranteed prize totals.

"We wanted to have really attractive, high-value guaranteed contests with low entry fees," said Jason Alderman, senior vice president of corporate communications for DraftKings. "That was incredibly successful. That's how we looked at Week 1. We accomplished what we set out to do. Week 2 and subsequent weeks will look differently."

Other industry experts and observers see the Week 1 overlay situation differently but note that it would be premature to use the NFL's opening week to judge the health of the DFS industry this football season: Week 2 will be a better gauge, they said.

"The opening weekend of the NFL is supposed to have the highest traffic and the highest dollar amounts spent of the daily fantasy year," said John Sullivan, 50, a former high-stakes daily fantasy player who quit playing after becoming disenchanted with the lopsided ecosystem. "It's clear these companies wildly overestimated the traffic they were going to get."

The companies' revenue primarily comes from a percentage of all its customers' entry fees taken off the top, a "rake" that ranges from 6 to 15 percent. DraftKings sent an email to some users at 9:27 a.m., Sunday, offering free entries into the Millionaire Maker contest that began at 1 p.m. ET. The free tickets, which are frequently offered to select players in various contests and contributed to Sunday's overlay, are often used to reactivate players at the start of football season.

"It was a tough weekend, a very soft weekend, and it ended up being a costly one," said a longtime industry insider close to DraftKings. "The timing couldn't have been worse."

The opening to the NFL season comes two weeks after DraftKings announced a $153 million round of funding with Revolution Growth, a venture capital firm co-founded by Ted Leonsis, owner of the Washington Wizards and Washington Capitals. When the deal was announced on Sept. 1, Jason Robins, the CEO of DraftKings, said, "I am excited to announce the company's latest funding round was 'oversubscribed,'" meaning there was more investment interest than shares of the company available.

An SEC filing shows the deal is classified as a $153,767,868 debt transaction. The document, a Form D filing, indicates Revolution was contracted to make the loan on Dec. 23, 2015, nine months before the deal was announced. The document does not state whether the deal will eventually be converted into an equity position for Revolution Growth, but the DraftKings spokesperson told ESPN that will happen. Revolution Growth did not return calls requesting comment.

"This reads to me like it's a $153 million loan," Robert M. McDonald, the Erwin P. Nemmers professor of finance at Northwestern University, said after reviewing the document signed and filed by DraftKings chief financial officer Tim Dent on Sept. 2. "Debt can mean a lot of different things, and there is no information here about the interest rate, whether the debt is potentially convertible into equity, and so forth."

The DraftKings spokesman declined to disclose the interest rate on the deal.

The December commitment from Revolution Growth came a month after New York Attorney General Eric Schneiderman issued cease-and-desist orders to DraftKings and FanDuel, claiming the companies were in violation of the state's gambling statutes. In June, the New York Legislature passed a bill clarifying the legality of fantasy sports and exempting it from the state's gambling laws and creating a 15 percent tax on licensed fantasy sports operators' revenues. The bill was signed into law by New York Gov. Andrew Cuomo on Aug. 3.

FanDuel has also raised $55 million in a loan from investors in recent months, which also will be converted into equity, The Wall Street Journal reported on Thursday.

In late August, Outside the Lines reported on the daily fantasy industry's struggles after DraftKings and FanDuel blanketed the airwaves a year ago with a $750 million advertising and marketing blitz. The ad buys seized the attention of Schneiderman and other federal and state authorities across the country. ESPN also reported that both companies owed millions of dollars to lobbyists, lawyers and others and that DraftKings had tried to renegotiate the terms of contracts with vendors and reduce affiliates' bonuses.

DraftKings' valuation was estimated at nearly $2 billion in July 2015, after a $300 million funding round but has since been cut dramatically by at least one investor. In February, Twentieth Century Fox told investors, in a quarterly report, that it had marked down the value of its $160 million stake in DraftKings by about 60 percent. Industry research firm Eilers & Krejick Gaming estimated the Revolution Growth deal was likely based on a valuation of around $1 billion. Several consultants told ESPN they believe it's considerably less than that, though, and say they still expect FanDuel and DraftKings will merge, possibly by the end of the NFL season.

After a tumultuous year, the daily fantasy industry has eyed the NFL football season as an opportunity to get back on track. DraftKings and FanDuel are marketing the game to new players by shifting focus from the financial part of fantasy sports to its social aspects. DraftKings said participation in its newly enhanced offerings that allow friends to compete against friends in private leagues were up three-fold from last season. The company also pointed to new sponsorships, including with Paramount Pictures, which sponsored DraftKings' free games, another new emphasis this season.

But on the heels of months of negative headlines, barrages from politicians and attorneys general across the country, impatience from nervous investors and a slew of legal challenges, the Week 1 overlay was worrisome to some.

"Overlay has its time and place, but with the tremendous growth in DFS these past few years, we're coming to the end of its planned usefulness," said Matt Primeaux, CEO of daily fantasy operator StarsDraft, who has faced the overlay issue often and added that he does not believe that most of last weekend's overlay was planned. "More than anything, this past weekend highlights the uphill battle certain operators face in overcoming last year's reputational hits, new high-volume player regulations, and the lingering effects that certain shortsighted policies and player incentives can have on the game."

Primeaux noted that it's common for guaranteed prize pool contests not to fill, especially in Week 1 of the NFL season, when player retention from the previous season is relatively unknown. Other factors also likely contributed to the unfilled contests, too. Newly instituted regulations in some states restrict the number of entries a player can submit into one contest at 150, and there was a dramatic reduction in television advertising compared to September 2015.

Anthony Crupi, television reporter for advertising industry site Ad Age, reviewed fantasy sports advertising on the opening Sunday and noticed not only a significant reduction in commercials but also when spots aired.

Last year, Crupi said DraftKings spent $6.58 million on in-game advertising from Thursday through Sunday during Week 1 of the 2015 NFL season. "Now, they're completely out of in-game," Crupi said

While fantasy commercials during the games vanished, Crupi found DraftKings and FanDuel did purchase spots on NFL pregame shows and even on syndicated sitcoms like "Friends." Overall, though, Crupi said the reduction of daily fantasy advertising was striking.

On top of the slashed television marketing campaigns, fantasy sites also are adjusting to new state regulations that didn't exist last year. New York and seven other states have passed fantasy sports laws and regulations this year, imposing age limits, prohibiting contests on college football, and restricting the number of entries in a contest. (Kansas passed a fantasy bill in 2015).

Jonathan Bales, a high-level daily fantasy player and author of "Fantasy Sports for Smart People," believes the new entry limits required by some states contributed to the overlay: "There was lots of action, but using just some simple math with conservative estimates, I don't think it's unreasonable to say some of the high-volume guys would have played hundreds of thousands [dollars] more without the limits - and potentially a lot more."